The Impact of Non-Audit Services on Capital Markets
64 Pages Posted: 7 Apr 2005
Date Written: October 2006
Abstract
The framers of the Sarbanes-Oxley Act (SOA) presume that non-audit services lower the quality of financial statements, so they have prohibited auditors from offering most non-audit services. In addition, regulators believe that non-audit services (NAS) may cause the auditor to be perceived as dependent in appearance, thus increasing information risk, even if they have no impact on the quality of financial statements.
I investigate two hypotheses using pre-SOA data. First, I ask whether the proportion of non-audit services fees to total fees has a positive or negative association with the ability of financial statements to predict a firm's future cash flows, which can be considered a measure of the quality of the statements. Second, I ask whether the proportion has a negative or positive association with the cost of capital and the bid/ask spread, controlling for the predictive ability. The cost of capital and the bid/ask spread serve as proxies of information risk.
Contrary to the proponents of prohibiting NAS, I find that the proportion of non-audit services fees to total fees has a positive association with the predictive ability. If we control for the quality of financial statements, non-audit services still have a negative association with the cost of capital and the bid/ask spread as proxies for information risk. These findings suggest that there are benefits from non-audit services, both to the quality of financial statements and to reducing information risk.
JEL Classification: G12, M41, M49
Suggested Citation: Suggested Citation
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